More and more retirees are being taxed on social security benefits. Changes in the law over the past decade have determined the age of receipt, the amount of benefits, and the level of taxation over the decades, meaning that many Americans are unexpectedly facing taxes on the public program they paid into during their working years. For someone who starts their Social Security benefit at or around $3,200 in 2024, it’s likely that at least some of it will be taxed if you have another source of retirement income. The question is: by how much.
Talk to a fiduciary financial advisor for free about your own retirement and tax strategies.
Up to 85% of Social Security benefits may be taxed based on your other sources of income. The preliminary income formulawhich is critical for calculating taxes on your Social Security benefits, adds half of your annual Social Security benefits to your adjusted gross income (AGI) and any non-taxable interest, such as from municipal bonds. This total then determines the taxable portion of social security benefits across different income limits.
Benefits are not taxed if:
Single filers: Your preliminary income is less than $25,000
Married filing jointly: Your preliminary income is less than $32,000
Up to 50% of benefits become taxable if:
Single filers: Your preliminary income is between $25,000 and $34,000
Married filing jointly: Your preliminary income is between $32,000 and $44,000.
Above these brackets, up to 85% of the benefits may be taxed.
For example, if you receive $3,200 in Social Security every month, that amounts to $38,400 per year. Let’s say you also withdraw $50,000 from an IRA in the same year. This makes your preliminary income $69,200 ($19,200 + $50,000). If you are a single filer, this is above the preliminary income threshold of $34,000, meaning 85% of your benefits will be taxed.
$38,400 annual Social Security benefit x 85% = $32,640 taxable benefits
This is too simple an example, but a financial advisor can walk you through calculations and other projections. Any amount of your Social Security benefit that is subject to tax will be taxed at your marginal income tax rate. For 2024, these rates, depending on your adjusted gross income, are as follows:
Marginal tax rates for 2024
Tax rate: 10%: Single filers ≤ $11,600 Married filing jointly ≤ $23,200 12%: Single filers > $11,600 Married jointly filers > $23,200 22%: Single filers > $47,150 Married jointly filers > $94,300 24%: Single filers > $100,525 Married jointly filing > $201,050 32%: Single filers > $191,950 Married jointly filers > $383,900 35%: Single filers > $243,725 Married jointly filing > $487,450 37%: Single filers > $609,350 Married jointly filers > $731,200
Consider these strategies to potentially reduce taxes on your Social Security benefits:
1. To delay or reduce withdrawals from retirement accounts: Reducing withdrawals from tax-deferred accounts such as IRAs or 401(k)s reduces provisional income. Choosing withdrawals from a Roth IRA or Roth 401(k), which are not considered taxable income, can also be beneficial.
2. Manage required minimum distributions (RMDs): Currently, RMDs become mandatory once you turn 73. If you are still employed with an active 401(k), RMDs from that account are not required. Qualified charitable distributions from an IRA can satisfy RMDs without counting as taxable income.
3. Roth conversion: Converting to a Roth IRA allows tax-free qualified withdrawals in the future and such withdrawals do not contribute to preliminary income. When reasonable, it is wise to convert amounts that keep the Social Security tax at 50% or less.
4. Avoid the “Tax Torpedo”: Taking taxable Social Security benefits can potentially push you into a higher tax bracket, known as the “tax torpedo effect.” Strategic planning of all sources of retirement income is critical to mitigating this. Consulting a financial advisor can provide personalized guidance in navigating these complexities.
If you would like to explore further how you can reduce your taxes in retirement, consult a financial advisor for free.
Effectively managing and reducing taxes on your Social Security benefits requires careful planning and strategy. By understanding the impact of different income sources on benefit taxation and exploring tax minimization strategies, retirees can better prepare for their financial future. Hiring a financial advisor can provide further personal insights and help in avoiding common tax pitfalls that come with retirement.
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